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Strong housing market, bold pricing strategy, distinctive position in the luxury market along with efficient cost-saving plans have been conducive to Toll Brothers Inc.’s (TOL - Free Report) impressive top and bottom-line growth. However, rising building materials and labor costs remain a concern.

A Look at Third-Quarter Fiscal 2018 Results

Recently, the country’s leading luxury homes builder reported earnings of $1.26 per share in the fiscal third quarter, beating the Zacks Consensus Estimate by 22.3%. The reported figure also grew 44.8% from the year-ago profit level. The company’s revenues of $1.91 billion in the quarter also topped the consensus mark of $1.81 billion and increased by an impressive 27% year over year, reflecting healthy new home industry and its unique position in the luxury market.

Deliveries increased 18% in units while contracts were up 12% in dollars and 7% in units on a year-over-year basis. Record third-quarter contracts and a quarter-end backlog signal solid revenue and earnings growth in fiscal 2019.

The average price of homes delivered was $851,900 in the quarter, up 7.6% from the year-ago level of $791,400.

Key Growth Drivers

Toll Brothers has been benefiting from brand quality, diversity of its product lines, and attractively located land pipeline across approximately 50 markets. The company mostly offers luxury homes and its communities are located in prosperous suburban areas with easy access to major cities. Luxury homes generally face limited competition. The company mostly caters to luxury move-up buyers who already possess a residence, and are looking for a shift to larger and better homes. These homebuyers are less sensitive to price changes. Toll Brothers enjoys greater pricing power than other homebuilding companies.

This is evident from its stellar performance. Toll Brothers achieved double-digit growth in earnings, revenues, contracts and backlog in fiscal 2017. The trend continued in the first nine months of fiscal 2018 as well, with the company registering double-digit growth in revenues (up 27.3%), contracts (up 20% in dollars) and backlog (up 22% in value). This reflects the health of the luxury new home market. The third quarter of fiscal 2018 marked the 16th consecutive period of year-over-year growth in contract dollars.

Shares of the company have gained 5.6% in the past month compared with the industry's 1.5% growth. Meanwhile, upward estimate revisions raise optimism about the stock’s earnings growth prospect. Estimates for the current and next year have moved upward by 2.2% and 3.7%, respectively, over the past 30 days. Strong housing demand and limited competition in the luxury housing space are likely to have a positive impact on the company's performance, thereby driving its share price. The company’s earnings are expected to grow 44.2% this year and 16% in the next.

Meanwhile, overall fundamentals of the housing market have remained strong in 2017, and can be expected to remain the same through the rest of 2018 and beyond. Steady job and wage growth, along with a recovering economy form the basis of rapidly increasing household formation.

Concerns

Rising building materials and labor costs are growing concerns for the company’s margin. Land prices are inflating due to limited availability. This could eat into homebuilders’ margins in the forthcoming quarters.

Moreover, the recently imposed tariff on imported steel and aluminum raises concern. An increase in import tariff will escalate raw material cost for home builders, who are already grappling with increased cost, thanks to the recent imposition of lumber tariff. It is important to note that the company’s adjusted gross margin in the fiscal third quarter contracted 70 basis points due to higher input costs.

D.R. Horton, Inc. (DHI - Free Report) is also a Zacks Rank #2 stock and its earnings for the current quarter are expected to grow 42%.

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